Most readers would already know that Japan Foods Holding's (Catalist:5OI) stock increased by 2.4% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. In this article, we decided to focus on Japan Foods Holding's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Japan Foods Holding

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Japan Foods Holding is:

22% = S$7.2m ÷ S$33m (Based on the trailing twelve months to September 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every SGD1 worth of shareholders' equity, the company generated SGD0.22 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Japan Foods Holding's Earnings Growth And 22% ROE

To begin with, Japan Foods Holding has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 2.8% the company's ROE is quite impressive. For this reason, Japan Foods Holding's five year net income decline of 8.2% raises the question as to why the high ROE didn't translate into earnings growth. So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Japan Foods Holding's performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 18% in the same period. This does appease the negative sentiment around the company to a certain extent.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Japan Foods Holding fairly valued compared to other companies? These 3 valuation measures might help you decide.